Could Fiat Chrysler Become the Valeant of the Auto Industry?

Reports are now emerging that Fiat Chrysler Automobiles N.V. (NYSE: FCAU) is being investigated by both the U.S. Securities and Exchange Commission (SEC) and the U.S. Department of Justice. The former is investigating the way the auto maker reports sales in its quarterly reports, but it is still unclear exactly why the Justice Department is involved.

FCA routinely books revenues when cars are shipped to dealers rather than when they are bought by the end consumer, though this is standard practice in the industry and probably not why an investigation is being performed. There have been previous complaints, both formal and informal, by car dealerships accusing FCA of high pressure sales tactics, and a previous lawsuit filed in Illinois alleged that the company paid dealers to inflate sales figures. FCA denies the claims.

If accounting practices are the problem, then the situation is eerily reminiscent of the beginning of Valeant Pharmaceuticals International Inc. (NYSE: VRX) double-counting troubles with its Philidor subsidiary that began that stock’s 90% crash in September 2015. There is no indication that FCA has done anything wrong and the carmaker is nowhere near its highs as was Valeant at the beginning of its scandal, but FCA has other problems that could compound its current hardships with regulators and drive its stock price down even further, regardless of whether or not it escapes these investigations unscathed.

The most glaring issue beyond these investigations is the current dire straits of the Italian banking sector, with $400 billion in bad loans. The infamous TARP bailout of 2008 totaled $700 billion, and the U.S. economy is about 10 times larger than Italy’s by gross domestic product, so the problems are much more concentrated there. While FCA may not be directly connected to this ocean of bad debt, it does own two captive finance banks it uses to secure loans for its customers in Italy. There is no telling exactly how exposed these captive finance companies are to the toxic mainstream Italian banking sector, but the interconnectedness of all banks is well known.

Even if there is no direct interdependency between FCA’s captive finance companies Fidis S.p.A. and FCA Bank S.p.A and the larger Italian banking sector, any so-called bail-in, where depositor money is forfeited directly to a troubled bank, will dramatically cool demand for car loans. A European Union court ruled on July 19 that a previous Slovenian bail-in in 2013 was in fact technically legal, setting the stage for another one in Italy should the need arise.

Of FCA’s 4.7 million unit sales last year, 446,000, or about 5%, came from Italy, by far its largest European market. The car manufacturer prides itself on achieving 75 straight months of year-over-year monthly sales growth, but a hit to Italian consumers’ ability to procure loans to finance car purchases will put a stop to that streak. As superficially impressive as that claim to fame is, it hasn’t helped the stock much at all. This belies the fact that the market isn’t buying the claim anyway. If and when that claim falls on paper, whether or not due to fraud, shares could easily go even lower.

To make matters worse, Bloomberg reports that Brexit contagion may spread to Italy first, given a referendum on constitutional reform coming up in October that could topple the current government if it does not pass.

Even assuming FCA breaks more records in every other segment, a hit to its Italian business will overshadow all that, especially because it would be right at home. If FCA shares are doing so poorly now with improving sales, imagine what the stock could do if sales actually fell substantially.

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